Knowledge that Transforms

We study the economic sources of stock-bond return comovements and their time variation using a dynamic factor model. We identify the economic factors employing a semistructural regime-switching model for state variables such as interest rates, inflation, the output gap, and cash flow growth. We also view risk aversion, uncertainty about inflation and output, and liquidity proxies as additional potential factors. We find that macroeconomic fundamentals contribute little to explaining stock and bond return correlations but that other factors, especially liquidity proxies, play a more important role. The macro factors are still important in fitting bond return volatility, whereas the "variance premium" is critical in explaining stock return volatility. However, the factor model primarily fails in fitting covariances. (JEL G11, G12, G14, E43, E44) Stock and bond returns in the United States display an average correlation of about 19% during the post-1968 period. Shiller and Beltratti (1992) underestimate the empirical correlation using a present value with constant discount rates, whereas Yet, these models generate realistically positive correlations using economic state variables.

We argue that dividend stickiness, the tendency of managers to keep dividends unchanged, implies that managers use a partially pooling dividend policy. We offer a model that demonstrates how such a policy can evolve endogenously in equilibrium. An informed manager who cares about the firm's intrinsic value as well as short-term stock price allocates earnings between investments and dividends. We show that there is a continuum of equilibria in which the dividend is constant for a range of realized earnings. Compared with the standard separating equilibrium, this partial pooling behavior induces higher firm value and lower underinvestment. We offer new empirical implications relating the pooling nature of dividend stickiness to the information environment of the firm, dividend prediction models, managerial incentives, and investment.

The paper explores how legal change affects lending behavior of banks in twelve transition economies of Central and Eastern Europe. In contrast to previous studies, we use bank level rather than aggregate data, which allows us to control for country level heterogeneity and analyze the effect of legal change on different types of lenders. Using a differences-in-differences methodology to analyze the within country variation of changes in creditor rights protection, we find that the credit supplied by banks increases subsequent to legal change. Further, we show that collateral law matters more for credit market development than bankruptcy law. We also show that entrants respond more strongly to legal change than incumbents. In particular, foreign-owned banks extend their lending volume substantially more than do domestic banks, be they private or state owned. The same holds when we use foreign greenfield banks as proxies for new entrants. These results are robust after controlling for a wide variety of possibilities.

We exploit an unexpected inflow of liquidity in an emerging market to study how capital is intermediated to firms. We find that backward-looking credit limit constraints imposed by banks make it difficult for firms to borrow, despite readily available bank liquidity, healthy aggregate demand, and a sharply falling cost of capital. The resulting aggregate failure to extend and retain capital in the economy suggests that agency costs that force banks to rely on sticky balance-sheet-based credit limits prevent emerging economies from effectively intermediating capital.

This article examines the information content and consequences of third-party voting advice that arrives as news at an interim stage in corporate proxy contests. We first document significant stock returns around announcements of proxy vote recommendations. We then develop a multi-equation empirical procedure for disentangling the price impact of prediction effects (changes in contest outcome probabilities) from the price impact of certification effects (changes in outcome-contingent valuations). Both effects are present in the data: Voting advice is both predictive about contest outcomes and informative about the ability of dissidents to add value. Consequently, proxy advice plays a dual informational role.

In this article, we use a large sample of transaction-level institutional trading data to analyze the role of institutional investors in initial public offerings (IPOs). The theoretical literature on IPOs has long argued that institutional investors possess private information about IPOs and that underpricing is a mechanism for compensating them to reveal this private information. We study whether institutions indeed have private information about IPOs, retain their information advantage in post-IPO trading, and are able to realize significant profits from their participation in IPOs. We also study institutional IPO allocations and allocation sales to analyze whether institutions play an important role in supporting IPOs in the aftermarket and are rewarded by underwriters for playing such a role. We find that institutions sell 70.2% of their IPO allocations in the first year, fully realize the “money left on the table,” and do not dissipate these profits in post-IPO trading. Further, institutions hold allocations in IPOs with weaker post-issue demand for a longer period, and they are rewarded for this by underwriters with more IPO allocations. Finally, institutional trading has predictive power for long-run IPO performance, especially in IPOs in which they received allocations; however, this predictive power decays over time. Overall, our results suggest that institutional investors possess significant private information about IPOs, play an important supportive role in the IPO aftermarket, and receive considerable compensation for their participation in IPOs.

Using word content analysis, we decompose information in the initial public offering prospectus into its standard and informative components. Greater informative content, as a proxy for premarket due diligence, results in more accurate offer prices and less underpricing, because it decreases the issuing firm's reliance on bookbuilding to price the issue. The opposite is true for standard content. Greater content from high reputation underwriters and issuing firm managers, through Management's Discussion and Analysis, contribute to the informativeness of the prospectus. Our results suggest that premarket due diligence and disclosure by underwriters and issuers can serve as a substitute for costly bookbuilding. The Author 2010. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: [email protected]., Oxford University Press.

While standard contract theory suggests that a Chief Executive Officer (CEO) should be paid relative to a benchmark that removes the effects of sector performance, there is evidence that CEO pay is strongly and positively related to such sector performance. In this article, we offer an explanation. We model a CEO charged with selecting the firm’s strategy that determines the firm’s exposure to sector performance. To incentivize the CEO to choose optimally, pay contracts will be positively and sometimes asymmetrically related to sector performance. Consistent with our predictions, the empirical analysis indicates that the observed sensitivity of pay to sector performance is almost fully confined to multisegment firms and is greater in firms that offer greater strategic flexibility to alter sector exposure, for more talented CEOs and for CEOs as compared to their subordinate executives. Our evidence is robust to alternate explanations such as CEO entrenchment.

In this paper we examine the effects of capital gains taxation on firms' investment and financing decisions. We develop a real-options model in which the timing of investment, the decision to default, and the firm's capital structure are endogenously and jointly determined. Our analysis demonstrates that the asymmetric taxation of capital gains and losses fosters investment by eroding the option value of waiting. It also shows that firms controlled by taxable investors employ more equity financing, the higher the firm's stock price and the worse the firm's historical performance. Using a large sample of U.S. industrial firms that are owned by taxable investors between 1970 and 2008, we present new evidence on corporate investment and financing policies, which is supportive of the model's predictions.

Panel data on corporate ownership in thirty-four countries between 1995 and 2006 reveal that newly public firms have concentrated ownership regardless of the level of investor protection. After listing, firms in countries with strong investor protection are more likely to experience decreases in ownership concentration; these decreases occur in response to growth opportunities, and they are associated with new share issuance. We conclude that ownership concentration falls after listing in countries with strong investor protection, because firms in these countries continue to raise capital and grow, diluting blockholders as a consequence.